Commentary: Prepayment of debt would trigger financial penalties

There is an old saying: “If you think education is expensive, try ignorance.”

In the recent candidate forums, we have seen candidates display ignorance of the facts that would be truly expensive to all Newport Beach residents.

Fact No. 1: Newport Beach’s finances are exceptionally strong. We are one of only five California cities to have a AAA — the highest possible — credit rating by all three major rating agencies, which laud us for “superior financial management” and “low debt levels.”

In ignorance of this fact, council candidate Scott Peotter (apparently joined on the same slate with Marshall Duffield and Kevin Muldoon) has proposed using cash reserves to pay down existing debt, including bonds and unfunded pension liabilities.

Apparently they are not aware that prepayment of our bonds would trigger up to a $44 million redemption premium. This is the cost of ignorance.

Making a lump-sum prepayment on unfunded pension liabilities is similarly unwise. A long-held tenet of investing is to “dollar cost average” by investing in steady increments in good times and bad, rather than making risky market timing bets.

Similarly, if the city makes a large prepayment bet on its unfunded pension liabilities, it dangerously, irrevocably lowers its cash operating reserves and risks large market losses. For example, had we paid off our unfunded pension liabilities in March of 2008, by the end of that year roughly $26 million of what we paid off would have been wasted because of the market crash.

No one is so prescient as to be able to avoid this risk, not Peotter, Duffield or Muldoon.

Instead, the city elected to follow a dollar cost averaging approach by paying down its unfunded liabilities over an accelerated, true-amortization period of 21 to 25 years (significantly faster than the maximum allowable 30 years), saving an estimated $113 million in interest expense. This avoids market-timing risk and preserves cash operating reserves, avoiding the cost of ignorance.

Fact No. 2: Newport Beach reported a 5.2% increase in its assessed property value in 2013, the best of any Orange County city coming out of the Great Recession. I posit that a principal financial goal of every Newport Beach homeowner is continuing that enhancement in the value of their homes.

The city’s budget is a zero-sum equation. Incremental dollars spent for one purpose reduce dollars spent for another purpose. The debt question is better cast as: “Are we better off to spend less on parks, libraries, programs, roads and fire stations, and instead spend more prepaying debt?”

Our AAA credit rating means amortization of our current debt and unfunded pension liabilities are easily handled within our budget. To accelerate debt repayment reduces the investments that make our community an ever more desirable place to live and our homes ever more valuable. Prepaying our debt will not increase the value of our homes or our quality of life one whit.

Thus, the cost of ignorance.

I spent a 30-year career as chief financial officer of Fortune 500 companies and am chairman of the City Council’s Finance Committee. I assure the residents of Newport Beach that the city’s finances are conservatively and prudently managed. This is not the time for dogmatic amateur hour at City Hall. The cost of ignorance is too expensive.

MIKE HENN is the 1st District councilman in Newport Beach.